Canada's Carney Says `Caution' Needed on Further Interest Rate Increases
Bank of Canada Governor Mark Carney said he’ll cut the bank’s growth forecast next month and signaled he’s likely to delay raising interest rates further.
“The unusual uncertainty surrounding the outlook warrants caution,” Carney, 45, said today in Windsor, Ontario. “With risks of a renewed U.S. slowdown, with constraints beginning to bind growth in emerging economies, and with domestic considerations that will slow consumption and housing activity in Canada, any further reduction in monetary stimulus would need to be carefully considered.”
The comments suggest the Bank of Canada has become more wary of breaking away from the world’s major central banks on policy, even though Canada is benefiting from rising demand for its commodities and its banks have largely escaped the financial crisis. Carney is alone among G-7 bankers to raise interest rates this year.
The U.S. Federal Reserve said Sept. 21 it’s prepared to ease monetary policy further and the Bank of England last week signaled policy makers are moving closer to adding stimulus. The international setting “isn’t consistent with an environment in which the Bank of Canada can carry forward with further hikes,” said David Tulk, senior macro strategist with TD Securities in Toronto.
Limits to Divergence
In his speech, Carney said that while Canada’s economy has been stronger than others, the global environment will limit how quickly Canada can raise interest rates. “While Canada’s circumstances and the discipline of the inflation target dictate a different policy stance than in the United States, there are limits to this divergence,” he said.
Carney is “telling market participants that your expectations for very low probability of us raising rates is correct,” Michael Gregory, a senior economist at BMO Capital Markets in Toronto, said in a telephone interview.
Canada’s economy can be expected to grow at a “modest pace” because of the effects of higher household debt levels and a slower global recovery, Carney said.
Growth is “more modest than we had expected and it will be more modest in the third and fourth quarters,” Carney told reporters following the speech, adding the bank “will put a finer point on that on Oct. 20 when we release our upcoming forecast,” referring to the next monetary policy report.
The bank raised its policy interest rate a quarter point to 1 percent on Sept. 8, the third increase this year, and investors had been pricing in strong likelihood as recently as two weeks ago of another rate increase next month. The bank’s next rate announcement is Oct. 19.
The chance of a quarter-point increase at the October meeting stood at 18 percent today before the speech, down from 20 percent yesterday and 40 percent two weeks ago, according to Bank of Nova Scotia data derived from overnight index swaps.
While Carney said the need for emergency measures has passed, “exceptionally stimulative” monetary policy is consistent with achieving the central bank’s 2 percent inflation target, he said, adding inflation has been “slightly lower” than expected.
Carney’s comments “set the bank up to pause on rates in October,” Avery Shenfeld, chief economist with Canadian Imperial Bank of Commerce, said in a note to clients.
Swap Rates Fall
The rate on the three-month overnight index swap, which measures what investors predict the central bank’s benchmark will average over time, fell 1.1 percentage points to 1.06 percent after the speech. The Canadian dollar pared gains following the report, trading at C$1.0283 per U.S. dollar at 3:25 p.m. in Toronto, from C$1.0326 yesterday.
Canadian retail, wholesale and manufacturing sales all unexpectedly fell in July and the country’s trade deficit widened to the biggest gap since at least 1971. Earlier today, Statistics Canada reported the economy shrank 0.1 percent in July, the first decline in 11 months, matching the median forecast of 22 economists surveyed by Bloomberg News.
Canadian Finance Minister Jim Flaherty today scaled back plans to withdraw stimulus by limiting proposed increases to payroll taxes amid signs of a slowing recovery. Carney said that will help to create jobs.
Carney said Canada’s economy won’t be able to rely as much on housing and personal consumption to fuel the recovery since households are poised to slow consumption growth because of rising debt levels. He said the rebound in the labor market, which has returned employment to pre-recession levels, has been led by public-sector jobs and “involuntary part-time” work.
“However welcome, these headline figures mask some important details,” Carney said. “In fact, although employment has regained its pre-recession level, hours worked have not.”
Carney also said returning to a “durable” global recovery will be a slow process that could take a decade. That could keep global interest rates “very low” and central banks in some major economies to expand unconventional monetary policies.
Carney said that since interest rates may need to remain low, other Canadian authorities should remain “vigilant” to ensure “financial imbalances” aren’t created due to low borrowing costs.